OECD ECONOMIC OUTLOOK

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OECD

Economic

Outlook

OECD Economic Outlook

Twice a year, the

OECD Economic Outlook

analyses the major trends and examines the economic

policies required to foster high and sustainable growth in member countries. Developments in major

non-OECD economies are also evaluated. The present issue covers the outlook to end-2009.

Together with a wide range of cross-country statistics, the

Outlook

provides a unique tool to keep

abreast of world economic developments.

In addition to the themes featured regularly, this issue contains a special chapter entitled

The implications of supply-side uncertainties for economic policy

, which addresses the following

questions:

• How deep is the impact of the recent oil and credit shocks on the productive potential

of OECD economies? To what extent can structural reforms help to soften it?

• How should economic policies respond to the uncertainty created by these shocks?

ISBN 978-92-64-04700-6

12 2008 02 1 P

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Volume

2008/

1 No.

83,

June

OECD

Economic

Outlook

Volume 2008/1

No. 83, June

OECD’s books, periodicals and statistical databases are now available via

www.SourceOECD.org

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our online library.

This book is available to subscribers to the following SourceOECD theme:

General Economics and Future Studies

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OECD

ECONOMIC

OUTLOOK

83

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AND DEVELOPMENT

The OECD is a unique forum where the governments of 30 democracies work together to address the economic, social and environmental challenges of globalisation. The OECD is also at the forefront of efforts to understand and to help governments respond to new developments and concerns, such as corporate governance, the information economy and the challenges of an ageing population. The Organisation provides a setting where governments can compare policy experiences, seek answers to common problems, identify good practice and work to co-ordinate domestic and international policies.

The OECD member countries are: Australia, Austria, Belgium, Canada, the Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, New Zealand, Norway, Poland, Portugal, the Slovak Republic, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. The Commission of the European Communities takes part in the work of the OECD.

OECD Publishing disseminates widely the results of the Organisation’s statistics gathering and research on economic, social and environmental issues, as well as the conventions, guidelines and standards agreed by its members.

Corrigenda to OECD publications may be found on line at: www.oecd.org/publishing/corrigenda. © OECD 2008

No reproduction, copy, transmission or translation of this publication may be made without written permission. Applications should be sent to OECD Publishing [email protected] or by fax 33 1 45 24 99 30. Permission to photocopy a portion of this work should be addressed to the Centre français d’exploitation du droit de copie (CFC), 20, rue des Grands-Augustins, 75006 Paris, France, fax 33 1 46 34 67 19, [email protected] or (for US only) to Copyright Clearance Center (CCC), 222 Rosewood Drive Danvers, MA 01923, USA, fax 1 978 646 8600, [email protected].

The French version of the OECD Economic Outlook is entitled Perspectives économiques de l’OCDE.

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Conventional signs

$ US dollar . Decimal point

¥ Japanese yen I, II Calendar half-years

£ Pound sterling Q1, Q4 Calendar quarters

€ Euro Billion Thousand million

mb/d Million barrels per day Trillion Thousand billion

. . Data not available s.a.a.r. Seasonally adjusted at annual rates

0 Nil or negligible n.s.a. Not seasonally adjusted

– Irrelevant

1.9. Delinquency and foreclosure rates are rising in the United States . . . 30

1.10. Commodity prices hover at new heights . . . 32

1.11. Oil demand in the OECD area. . . 33

1.12. Contributions to headline consumer price inflation. . . 36

1.13. Exchange rates are adjusting . . . 37

1.14. Global growth is slowing . . . 45

1.15. Vulnerability to headwinds differs across countries . . . 47

1.16. Headline and underlying inflation measures . . . 50

1.17. Producer price inflation has picked up sharply . . . 51

1.18. Corporate tax revenues have slowed sharply . . . 55

1.19. Low interest rates and the housing investment boom, 2001-06 . . . 59

1.20. Comparison of monetary (MCI) and financial (FCI) condition indexes . . . 69

3.1. The estimated NAIRU in the United States and the euro area . . . 214

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Summary of projections

2007 2008 2009 Fourth quarter

Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2007 2008 2009

Per cent

Real GDP growth

United States 2.2 1.2 1.1 0.6 1.0 -0.5 0.7 0.2 1.0 1.4 2.2 3.0 2.5 0.3 1.9

Japan 2.1 1.7 1.5 2.6 3.3 1.1 1.0 1.3 1.6 1.6 1.7 1.7 1.5 1.7 1.6

Euro area 2.6 1.7 1.4 1.2 3.1 0.2 1.1 1.2 1.4 1.7 1.8 1.9 2.1 1.4 1.7

Total OECD 2.7 1.8 1.7 1.7 2.1 0.5 1.2 1.2 1.7 2.0 2.4 2.7 2.6 1.3 2.2

Inflation1

United States 2.5 3.2 2.0 3.9 3.5 3.6 2.4 2.0 1.8 1.7 1.6 1.6 3.4 2.9 1.6

Japan 0.1 0.9 0.4 1.6 1.2 0.6 0.3 0.3 0.3 0.4 0.5 0.6 0.5 0.6 0.5

Euro area 2.1 3.4 2.4 4.8 4.2 3.3 2.6 2.4 2.3 2.2 2.1 2.0 2.9 3.1 2.1

Total OECD 2.2 3.0 2.1 3.5 3.4 3.2 2.5 2.3 2.0 1.9 1.8 1.8 2.8 2.8 1.9

Unemployment rate2

United States 4.6 5.4 6.1 4.8 4.9 5.2 5.5 5.8 6.0 6.2 6.2 6.1 4.8 5.8 6.1

Japan 3.9 3.8 3.8 3.9 3.8 3.8 3.8 3.9 3.9 3.8 3.7 3.7 3.9 3.9 3.7

Euro area 7.4 7.2 7.4 7.1 7.1 7.2 7.2 7.3 7.4 7.4 7.5 7.5 7.1 7.3 7.5

Total OECD 5.6 5.7 6.0 5.5 5.6 5.7 5.7 5.9 6.0 6.0 6.0 6.0 5.5 5.9 6.0

World trade growth 7.1 6.3 6.6 4.8 6.5 6.1 6.1 6.3 6.6 6.9 7.0 7.1 7.2 6.2 6.9

Current account balance3

United States -5.3 -5.0 -4.4

Japan 4.8 4.4 4.4

Euro area 0.2 0.1 0.0

Total OECD -1.4 -1.3 -1.1

2007 2008 2009

Cyclically-adjusted fiscal balance4

United States -3.2 -5.2 -4.4

Japan -2.6 -1.6 -2.5

Euro area -0.7 -1.0 -0.8

Total OECD -2.0 -2.8 -2.5

Short-term interest rate

United States 5.3 2.7 3.1 5.0 3.2 2.6 2.6 2.5 2.3 2.6 3.4 4.0

Japan 0.7 0.8 0.7 0.8 0.8 0.9 0.9 0.8 0.7 0.7 0.8 0.8

Euro area 4.3 4.5 4.1 4.7 4.5 4.5 4.5 4.4 4.2 4.1 4.1 4.1

Note:

Assumptions underlying the projections include: - no change in actual and announced fiscal policies;

- unchanged exchange rates as from 13 May 2008; in particular 1$ = 104.44 yen and 0.64 €; The cut-off date for other information used in the compilation of the projections is 23 May 2008.

1. USA; price index for personal consumption expenditure, Japan; consumer price index and the euro area; harmonised index of consumer prices. 2. Per cent of the labour force.

3. Per cent of GDP. 4. Per cent of potential GDP.

Source: OECD Economic Outlook 83 database.

Real GDP growth, inflation (measured by the increase in the consumer price index or private consumption deflator for total OECD) and world trade growth (the arithmetic average of world merchandise import and export volumes) are seasonally and working-day-adjusted annual rates. The "fourth quarter" columns are expressed in year-on-year growth rates where appropriate and in levels otherwise. Interest rates are for the United States: 3-month eurodollar deposit; Japan: 3-month certificate of deposits; euro area: 3-month interbank rate.

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EDITORIAL

AFTER THE STORM?

S

everal quarters of weak growth lie ahead for most OECD economies. At the same time, headline inflation could remain high for some time to come. This scenario is the combined outcome of financial market turmoil, cooling housing markets and sharply higher commodity prices. The projections in this OECD Economic Outlook carry both upside and downside risks and embody the following main features: ● US activity is essentially flat through 2008 and then picks up thereafter as housing adjustment ends,

credit conditions normalise and the effects of past monetary ease are felt. With substantial capacity slack and under the assumption of unchanged commodity prices, inflation moderates significantly. Robust export growth, on the back of recent dollar depreciation, helps to narrow the external deficit to around 4½ per cent of GDP next year.

● Euro area activity is restrained through the current year by tighter credit, squeezed real incomes, lower export market growth and market share losses. Growth gradually recovers as these factors fade, though falling housing investment remains a drag throughout. Despite currency appreciation inflationary pressures are strong and, with capacity use moving just slightly below its normal level, it is only towards the end of the projection period that inflation reverts to 2%.

● Japan has been less directly affected by financial turmoil but growth is held back in the near term by slower export growth, weak household incomes and some hesitancy on the part of firms to invest. As growth regains momentum, inflation also gradually moves up to reach a rate around ½ per cent.

The current economic situation is particularly unsettled and the distribution of risk around the projections is wide. In this environment, economic policy in OECD countries needs to take into account the growing importance of developments in non-OECD economies; the influences of higher energy and credit costs on the supply side of OECD economies; the possibility of upward drift in inflation expectations; and the uncertainty as to the effects of financial market developments on growth and inflation.

Globalisation was an important driver of the economic cycle on the way up as non-OECD economies exported both cheap manufactured products and surplus saving, helping to keep OECD interest rates low and thereby boosting asset demand and prices. Currently, robust non-OECD growth is an important factor behind high commodity prices. And, going forward, continued rapid import growth in non-OECD countries will help to cushion activity in the OECD area. At the same time, buoyant non-OECD demand is leading to inflationary pressure in these countries and sustains tensions in commodity markets.

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Macroeconomic policy is also faced with a more hazy picture of OECD economies’ supply capacity than previously. Both globalisation and structural reform have boosted potential growth rates in the past and will hopefully continue to do so. But sharply higher energy prices and higher costs of capital as a result of financial market developments could sap potential growth. The chapter on supply side uncertainties in this Economic Outlook provides some illustrative calculations of these effects. While such quantifications are inherently uncertain, macroeconomic policy needs to be alert to the possibility that capacity limits could be tighter than posited.

Signs that inflation expectations could be drifting up also call for caution. Well-anchored inflation expectations are a crucial policy asset earned, in many cases, through painful disinflation in past decades. Confidence in price stability can be enhanced through various institutional arrangements coupled with careful communication but the ultimate confidence-enhancing measure is to actually deliver.

Financial market influences on growth remain hard to gauge. The odds have improved that financial market dislocation has passed its peak, but this is far from a foregone conclusion. And even if true, the effects on growth are likely to linger. Uncertainty is compounded by the likely feed-back from a weaker growth environment on financial markets and by the fact that problems at financial institutions can be resolved in different ways. In this regard, it is desirable for capital deficiency to be addressed through the injection of new capital and asset disposal rather than through credit compression. While a slower than projected normalisation of financial markets cannot be excluded, nor can a more rapid restoration, especially if improved confidence were to create a positive feed-back between financial asset prices and institutions’ balance sheets. Central banks need to stand ready to deal with both eventualities.

Apart from dealing with the fall-out on demand from current financial market distress, it will be necessary to re-visit the prudential and supervisory framework for financial markets. The Financial Stability Forum has recently provided directions for change in these areas and efforts towards implementation are in some cases already underway. It will be important to carry through with the required reforms, also when the memory of recent turmoil becomes more distant and those subject to tighter regulation more likely to resist. At the same time, regulatory overkill needs to be avoided. Many recent innovations in financial markets have the capacity to improve welfare, when appropriately harnessed.

It also needs to be considered whether and how the tendency for financial markets to generate cycles can best be addressed. This may involve both regulatory initiatives to attempt to damp inherent cyclicality as well as a reconsideration of monetary policy conduct. Dynamic provisioning and reserve requirements are some of the instruments that may help smooth credit cycles and increase resilience of the financial sector but they are not without drawbacks. Concerning monetary policy, it may not be desirable nor feasible to prick bubbles, but greater symmetry in the response to credit booms and busts may be useful.

As regards fiscal policy, the United States has introduced temporary tax rebates that seem to be appropriately timed and targeted and therefore stand a good chance of providing needed support to activity. The issue of fiscal stimulus has also been broached for other OECD regions but, in general, the case for such initiatives is weak. Inflation pressures in the euro area are such that any stimulus might have to be offset by monetary policy and, in any case, automatic fiscal stabilisers are much stronger than in the United States. In Japan, the fiscal situation does not allow fiscal expansion and the economy is anyway less directly affected by financial turmoil than other OECD countries.

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Overall, OECD economies have been hit by strong gales over the recent past and it will take time and well-judged policies to get back on course. Nonetheless, it is a tribute to the effects of past structural reform and well-honed macro-policy frameworks that the effects of this near-perfect storm have not been worse. This underlines the need to persevere with such policies.

28 May 2008

Jørgen Elmeskov

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Chapter 1 GENERAL ASSESSMENT

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Overview

Growth is slowing

in response to strong headwinds

The odds are improving that financial market turmoil has passed its peak. Still, its fallout will continue to act as a brake on growth for considerable time to come. Other headwinds causing the on-going slowdown in activity in the OECD area are likely to continue, including cooling housing markets and high commodity prices. Weakness has been most marked in the United States. However, despite buoyancy during the first quarter of 2008 in Japan and Germany, the slowdown is set to generalise across virtually all OECD economies (Table 1.1). There is also some slowdown outside the OECD area, albeit partly induced by policies aimed at restraining inflation.

A generalised but not uniform slowdown

Area-wide growth, after reaching a trough of ½ per cent (annualised) in the second quarter, the lowest since the slump following the high-tech bubble, is projected to remain weak through the rest of this year. This aggregate picture masks considerable divergence in growth across countries. Indicative of such divergences, at the end of 2007 the United States, the euro area and Japan were all estimated to be running at capacity, but by the end of 2009, output will have fallen more than 2% below potential in the United States, ¾ per cent below in the euro area and remain slightly above potential in Japan. Other economies which will be among the hardest hit, judged by how far activity is below potential

Table 1.1. Growth is slowing sharply

OECD area, unless noted otherwise

1 2 http://dx.doi.org/10.1787/362735687425

Average 2007 2008 2009

1995-2004 2005 2006 2007 2008 2009 q4 q4 q4

Per cent

Real GDP growth1 2.7 2.7 3.1 2.7 1.8 1.7 2.6 1.3 2.2 United States 3.1 3.1 2.9 2.2 1.2 1.1 2.5 0.3 1.9

Euro area 2.2 1.7 2.9 2.6 1.7 1.4 2.1 1.4 1.7

Japan 1.1 1.9 2.4 2.1 1.7 1.5 1.5 1.7 1.6

Output gap2 -0.3 -0.3 0.2 0.4 -0.3 -1.1

Unemployment rate3 6.6 6.5 6.0 5.6 5.7 6.0 5.5 5.9 6.0

Inflation4 3.5 2.2 2.3 2.2 3.0 2.1 2.8 2.8 1.9

Fiscal balance5 -2.3 -3.0 -1.5 -1.5 -2.5 -2.6 1. Year-on-year increase; last three columns show the increase over a year earlier. 2. Per cent of potential GDP.

3. Per cent of labour force.

4. Private consumption deflator. Year-on-year increase; last 3 columns show the increase over a year earlier. 5. Per cent of GDP.

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output, include: those most directly affected by financial turmoil, notably Iceland; those where housing downturns are most pronounced, especially Ireland and Spain; the United Kingdom which may be more vulnerable because of the importance of financial markets and links between financial turmoil, the mortgage market and spending by households; those with closest ties to the United States, in particular Canada and Mexico; and those starting from a weak position, notably Italy. Growth in the emerging markets, while moderating, remains strong, especially in China.

Financial turmoil implies risks on both sides

Continued turbulence in financial markets has spread to new markets and institutions, reaching beyond the origin of the problems with the US subprime mortgages and derived products and leading to a generalised wariness and re-pricing of risk. Recent signs suggest that conditions in some financial markets are improving, but further financial disruption cannot be excluded, with causality likely to flow in both directions between weak activity and financial pressures. While the resulting activity risks imply a fat downside tail to the probability distribution around the projection, there are also upside risks associated with a faster dissipation of financial turmoil. Overall, the projection is best characterised as a most likely outcome.

A pick-up in inflation expectations may inhibit policy stimulus

The case for macroeconomic policy stimulus has been stronger in the United States than in Europe or Japan and both US monetary and fiscal policy have already acted forcefully. Going forward, the scope for p o l i cy s u p p o r t t o d e c e l e rat in g a c t iv i t y d ep e n d s on i nf la t i o n developments. Soaring oil, food and other commodity prices have led to a sustained pickup in headline inflation rates and increases in producer price inflation suggest further impending cost pressures. In these circumstances, a ratcheting up of inflation expectations remains a potent threat.

Policy rates should remain on hold in the major regions this year

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Recent developments

Growth is now slowing in the OECD area

The US slowdown has broadened

Activity has decelerated in a highly differentiated manner across most of the OECD area (Figure 1.1). The US economy has been very weak and growth might be negative in the second quarter of the year. The housing market remains massively oversupplied, with residential construction continuing to plunge at steep rates and house prices declining. Private consumption weakened significantly in the first part of 2008 as high inflation, driven by gasoline and food prices, reduces consumers’ purchasing power, tighter credit begins to bite and falling house prices weighed on households’ wealth and collateral. Business investment, which began decelerating last year, declined in the first quarter of 2008, reflecting the weakening of actual and prospective demand. By contrast, exports have remained relatively strong, benefitting from dollar depreciation and hitherto strong world trade growth. This, together with subdued imports, has led to a significant fall in the US current account deficit to just below 5% of GDP by the end of 2007, down from 6½ per cent in the middle of 2006.

Figure 1.1. A generalised, but differentiated, slowdown

Note:The value for 2008H1 is based on an annualised growth rate between 2007H2 and 2008H1 and is partly estimated. Source: OECD Economic Outlook 83 database.

1 2 http://dx.doi.org/10.1787/363388866383

2006 2007 2008H1

0 1 2 3 4 %

OECD

Actual GDP growth Potential GDP growth

2006 2007 2008H1

United States

2006 2007 2008H1 0

1 2 3 4

%

Euro area

2006 2007 2008H1

0 1 2 3 4 %

Japan

2006 2007 2008H1

United Kingdom

2006 2007 2008H1 0

1 2 3 4

%

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The euro area has been relatively resilient

Activity in the euro area has held up well to date, with growth in the first quarter picking up to an annualised rate of 3% due to surprising strength in Germany and, to a lesser extent, France. However, much of the positive surprise in Germany may reflect temporary factors,1 implying a “pay-back” subtraction from growth in the second quarter. Private consumption in the euro area continues to be sluggish in the face of rising inflation, driven by strong increases in energy and food prices. Over the past year, robust business investment and exports – which were particularly strong in Germany – have partly compensated for this weakness. However, there are increasing signs that the appreciation of the euro – up by some 10% in real effective terms since the beginning of 2006 – is damping export growth. Residential construction investment is falling, reflecting large corrections in a few countries, notably in Spain and Ireland, together with a continued slowing in most others.

Growth in Japan has moderated

In Japan, GDP grew at an underlying rate of some 2% last year, about ½ percentage point above potential and advanced strongly in the first quarter of this year as well. Recent strength reflects a rebound in housing investment after the disruption caused by the regulatory change introduced in the middle of last year as well a continuation of rapid export growth. However, business investment, which has been the other engine of growth in recent years, fell in the first quarter and softening business confidence and survey evidence point to further near term weakness. At the same time, rising gasoline and food prices will moderate the growth of private consumption.

China has continued to grow strongly…

Growth in major emerging market economies has continued to be brisk. In China the economy slowed to a still robust year-on-year growth rate of 10½ per cent in the first quarter of 2008. The contribution of exports continues to diminish and that of domestic demand to increase. Headline consumer price inflation remains high at above 8% in the first quarter. While sharp increases in food prices continue to be the main driver of headline inflation, upstream pricing pressures remain elevated with producer prices having accelerated in aggregate and across a broad range of industry segments. In response, the central bank has continued policy tightening, lifting interest rates and sterilising foreign exchange inflows via increased reserve ratios for commercial banks and bond issuance. Since the second half of last year, there has been a more rapid appreciation of the renminbi vis-à-vis the dollar, although in effective terms the appreciation has been much more modest.

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… as have other emerging economies

Growth in India slackened by about 2 percentage points during 2007 to 8½ per cent year-on-year in the final quarter. At the same time, inflationary pressures have re-emerged. Growth in Russia accelerated in 2007 on the back of strong increases in investment and consumption, to slightly above 8% for the year. In Brazil, GDP growth firmed to 5½ per cent in 2007, the fastest pace of expansion since 2004, driven by continued strength in private consumption and a rebound in investment.

Labour markets are softening

Employment has declined sharply in the United States

As activity has weakened, employment growth in the OECD area has slowed (Table 1.2). The slowdown has been most marked in the United States where private payroll employment has fallen since the end of last year at a pace which in the past has signalled the onset of a recession. As a consequence the unemployment rate has risen to around the estimated structural rate of 5%, while several indicators are pointing to easing wage pressure (Table 1.3).

Labour markets remain tight in the euro area…

In the euro area the slowdown in employment growth is more recent and more moderate, so that the unemployment rate remains at its lowest level since at least the beginning of the 1990s, below the OECD’s estimate of its structural level. Productivity growth has weakened further, leading to some pick-up in unit labour costs which going into 2008 were increasing at about 2% per annum (Table 1.3). While this pick-up is a feature of most euro area countries there are significant differences between them; in Germany the rate of increase is still well below the average, France is close to the average, while Italy and Spain are well above it. Moreover, weak productivity growth has allowed little room for increases in euro area real compensation per employee over the past five years, helping to explain both weak consumption and rising inflationary pressures.

Table 1.2. Labour markets have begun to weaken

1 2 http://dx.doi.org/10.1787/362765655161

2005 2006 2007 2007 q3

2007 q4

2008 q1

2008 q2

Percentage change from previous period, seasonally adjusted at annual rates

Employment

United States 1.8 1.9 1.1 0.3 0.7 -0.6 -0.2 Japan 0.4 0.4 0.5 -1.5 0.9 -0.3 -0.2 Euro area 1.1 1.6 1.8 1.8 1.2 1.3 0.2

Labour force

United States 1.3 1.4 1.1 1.0 1.2 0.0 0.9

Japan 0.1 0.1 0.2 -1.7 1.3 -0.7 0.0

Euro area 1.1 0.9 0.9 1.2 0.6 0.9 0.7

Unemployment rate Per cent of labour force

United States 5.1 4.6 4.6 4.7 4.8 4.9 5.2

Japan 4.4 4.1 3.9 3.8 3.9 3.8 3.8

Euro area 8.8 8.2 7.4 7.3 7.1 7.1 7.2

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... and in Japan where there are encouraging signs of wage growth

Employment creation has also continued in Japan, although on a slowing trajectory, with the unemployment rate stabilising close to the lowest level in a decade. In the past, falling hourly compensation and unit labour costs have been a feature of Japan’s deflationary trap. However, wages for full-time workers increased in early 2008 as a consequence of a tight labour market and because the shift towards lower-paid non-regular employment, which reduces wage costs, appears to have slowed.

Forces shaping the outlook and associated risks

OECD economies face

a triple adverse shock as globalisation evolves

OECD economies are facing three adverse shocks which are reducing demand: financial turmoil, a downturn in the global housing cycle, and a squeeze on real incomes from soaring energy and food prices.2 At the same time higher commodity prices are putting upward pressure on headline inflation, while higher oil prices and increases in the cost of capital resulting from the financial turmoil may be durably curtailing potential supply (Chapter 3). These three shocks are inextricably linked to the growing importance of emerging markets in the global economy. Most obviously, the increased demand for commodities from these countries has led to soaring prices. In addition, the credit, housing and asset price cycle which has now turned was fuelled by low interest rates on the back

Table 1.3. Wage developments remain moderate

1 2 http://dx.doi.org/10.1787/362780678120

2005 2006 2007 2007 q3

2007 q4

2008 q1

2008 q2

Percentage change from previous year

Labour productivity1

United States 1.5 1.1 1.3 2.0 2.0 2.3 1.5

Japan 1.5 2.0 1.6 1.6 1.2 1.0 2.3

Euro area 0.6 1.3 0.8 0.7 0.3 0.5 0.6

Compensation per employee

United States 3.5 4.0 4.4 5.0 3.8 3.3 3.8

Japan 0.1 0.2 -0.6 -0.8 -1.0 0.6 1.1

Euro area 1.5 2.2 2.3 2.2 2.3 2.2 2.8

Real compensation per employee2

United States 0.3 0.8 1.7 2.5 1.2 1.2 2.1

Japan 1.4 1.1 0.1 -0.2 0.3 2.1 2.5

Euro area -0.4 0.3 0.1 0.0 0.1 -0.1 0.5

Unit labour cost

United States 2.2 3.0 3.3 3.0 2.2 1.3 2.6

Japan -1.1 -0.8 -1.8 -1.9 -1.5 -0.5 -0.6

Euro area 1.1 1.1 1.7 1.6 2.3 2.0 2.4

Note: For the total economy, year-on-year increase; last 4 columns show the increase over a year earlier. For 2008, estimates and projections.

1. Productivity is measured on a per person basis. 2. Deflated by the GDP deflator.

Source: OECD Economic Outlook 83 database.

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of both the so-called global savings glut, to which emerging economies contributed importantly, and imported disinflation, as a result of penetration by cheap manufactured products.

Financial turmoil has deepened

Banks have been hit hard by the crisis

The turmoil that hit financial markets in the summer of 2007 has many features similar to previous credit crises (Reinhart and Rogoff, 2008), with a distinguishing characteristic this time around being the complexity and opaqueness of the financial assets involved. As in several previous crises, the most visibly affected institutions have been banks and, in the United States and elsewhere, many have already reported sizeable write-downs and credit losses linked directly or indirectly to the troubled subprime mortgage market, amounting so far to about $380 billion.3 Banks are also being affected by an involuntary expansion of their balance sheets,4 while the share of risky assets they are holding has increased.

How balance sheets are repaired has growth implications

The problems that banks are encountering are playing a key role in the transmission of the crisis both to other financial institutions and to the real side of the economy. Going forward, much will depend on the manner in which bank balance sheets are restructured. In this respect, large-scale recapitalisation, or the transfer of assets to other agents, offers the best way to quickly restore the functioning of loan markets. Raising new capital has not been easy in a market where equity prices of financial institutions have been falling (Figure 1.2) and earlier high profile recapitalisations have entailed large losses for investors, including some

3. The estimate of reported credit losses and write-downs is based on recent data (19 May) from Bloomberg for more than 100 of the world’s largest banks and securities firms. Some of these write-downs are based on mark-to-market values that may over estimate the fall in asset prices. Indeed, as pointed out for instance by the Bank of England (2008a), because of illiquidity, thin markets and the confidence crisis, current market prices have become unreliable predictors of potential losses and are likely to lead to over-estimations. OECD estimates of the total credit losses associated with residential mortgage backed securities range from $350 to $420 billion, although not all of the losses are in banks and security firms (Blundell-Wignall, 2008). Instead of market prices, these estimates rely on a default model approach and assume a 40% to 50% recovery rate on defaulting loans and an economic and house price scenario benchmarked against previous episodes. This price scenario implies, however, a smaller fall in house prices than the one assumed in this Economic Outlook,

suggesting that total losses could be possibly higher unless the recovery rate on defaulting loans turns out to be better than expected. This estimate is nevertheless close to that by Greenlaw et al. (2008). It is much lower than the estimates in IMF (2008) that not only partly relies on market prices, but also includes possible losses on a wide range of other assets.

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sovereign wealth funds.5 This could change, however, once perceptions are in place that share prices have hit bottom though existing shareholders may be reluctant to accept dilution of their stake at rock-bottom prices. As concerns the transfer of assets, a number of recent transactions have allowed banks to sell off some of their loan-book. But such transfers remain limited to a few institutions and proposals to create an ad hoc structure to park bad assets, financed either by private or public money, have not succeeded.

Credit to other financial institutions is being cut

The other option is to shrink balance sheets by reducing lending, which can have negative spillover effects to other areas of the economy, and in turn may trigger additional losses in the financial sector. Indeed,

Figure 1.2. Share prices of financial institutions have fallen sharply

Share price indices, 1 January 2007 = 100

Source: Datastream.

1 2 http://dx.doi.org/10.1787/363513242356

60 70 80 90 100 110 120 130

Non-financial sector Financial sector

Q1 Q2 Q3 Q4 Q1

2007 2008

United States

60 70 80 90 100 110 120 130

Q1 Q2 Q3 Q4 Q1

2007 2008

Euro area

60 70 80 90 100 110 120 130

Q1 Q2 Q3 Q4 Q1

2007 2008

Japan

60 70 80 90 100 110 120 130

Q1 Q2 Q3 Q4 Q1

2007 2008

United Kingdom

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commercial banks in the United States and Europe have been tightening lending standards to both households and businesses (Figure 1.3) and the effects are evident in a number of market segments, including loans to other financial institutions, like hedge funds. These institutions, which are often highly leveraged, have been forced to sell assets into illiquid

Figure 1.3. Banks are tightening lending standards

Net percentage of banks tightening credit

1. In the United States, starting in 2007q2 changes in standards for prime, non conventional (not displayed on this figure) and subprime mortgage loans are reported separately.

2. The Bank of Japan publishes a diffusion index of “accommodative” minus “severe”. The data have then been transformed to show the net percentage of banks tightening credit, as for the United States and the euro area.

Source: US Federal Reserve, Senior Loan Officer Survey; ECB, The euro area bank lending survey; and Bank of Japan, Senior Loan Officer Opinion Survey.

1 2 http://dx.doi.org/10.1787/363577436131

2000 2001 2002 2003 2004 2005 2006 2007

-40 -30 -20 -10 0 10 20 30 40 50 60 70 80 Small firms

2000 2001 2002 2003 2004 2005 2006 2007 -40

-30 -20 -10 0 10 20 30 40 50 60 70 80

United States Euro area _{Large firms}

2000 2001 2002 2003 2004 2005 2006 2007

-40 -30 -20 -10 0 10 20 30 40 50 60 70 80

US subprime mortgages

US prime mortgages

House purchase¹

2000 2001 2002 2003 2004 2005 2006 2007 -40

-30 -20 -10 0 10 20 30 40 50 60 70 80

United States - credit cards United States - other consumer loans Euro area

Consumer loans

2000 2001 2002 2003 2004 2005 2006 2007

-40 -30 -20 -10 0 10 20 30 40 50 60 70 80

Commercial real estate loans

2000 2001 2002 2003 2004 2005 2006 2007 -70

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markets to either meet margin calls or restore targeted leverage ratios, further weakening prices and amplifying the deleveraging process (Greenlaw et al., 2008).

As growth weakens financial tensions are spreading

The re-pricing of risks has spread from opaque securitised products to other assets classes, including traditional bonds and equities. At the same time, government bonds in the major OECD countries have benefitted from a flight to quality, though this effect has diminished more recently in line with greater optimism that turmoil is being contained. The OECD synthetic indicator of corporate and emerging market bond risk premia has increased sharply since the autumn of 2007, to a level that cannot be accounted for by actual default rates, nor by a return of these rates to their historical norms (Figure 1.4). Hence, current prices seem not only to reflect the unwinding of the under-pricing of risk that prevailed before the turmoil but also the anticipation of much weaker growth and a corresponding surge in defaults as well as some possible overshooting. This reflects an on-going shift in the causal links between financial markets and the economy at large. Until recently, the causality has been mainly from financial strains to activity; it has now started to operate in both directions, at least in the United States, creating negative feedback effects and possibly prolonging the headwinds from financial dislocation.

Figure 1.4. Risk premia have risen sharply

Deviation from average (in standard deviations of synthetic risk premia indicator1)

1. The synthetic measure is derived from risk proxies for corporate and emerging market bonds. In regression analysis, it seems to be well explained by a set of “fundamentals” including global short-term interest rates and liquidity, corporate default rates and the OECD’s leading economic indicators, a proxy for expectations of the near-term outlook for the OECD cyclical position. The ‘predicted’ values shown are the model predictions. See OECD (2006a).

Source:Datastream; and OECD calculations.

1 2 http://dx.doi.org/10.1787/363583732654

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

-2 -1 0 1 2 3 4

If default rates reverted to historical averages (1985-2007) Synthetic risk premia indicator - actual values

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Overall financial market conditions are tight

The fallout from the turmoil is weighing on US growth via several channels. In an attempt to synthesise their effect on growth, a broad indicator of financial conditions has been constructed (Figure 1.5). The index comprises short- and long-term real interest rates on government paper, the effective real exchange rate as well as a measure of non-price credit tightening, bond market spreads and stock prices. On this indicator, financial conditions have tightened significantly since summer 2007 despite lower real short- and long-term interest rates and the real effective depreciation of the dollar. The overall negative impact on GDP implied by the tightening of the index to date would be slightly above 1% (for details of these calculations and the uncertainty surrounding them, see Table 1.14 in Appendix 1.A2).6

Figure 1.5. US financial conditions have tightened despite depreciation and monetary easing

Note: A unit increase in the index corresponds to an effect on GDP equivalent to an increase in real long-term interest rates of 1 percentage point. When necessary underlying variables for 2008Q2 have been projected in line with the other financial variables in this publication (Appendix 1.A2 for more details).

Source: OECD calculations (Appendix 1.A2).

1 2 http://dx.doi.org/10.1787/363606638408

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

-6 -4 -2 0 2 4 6

Real exchange rate Real short interest rate Real long interest rate Spreads

Credit conditions Stock market

Financial condition index

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The turmoil is also weighing on activity elsewhere

In the euro area and the United Kingdom, write-downs and expected further losses appear much lower than in the United States, but banks have on average smaller capital cushions than in the United States and are also facing involuntary re-intermediation. Credit standards have already been tightened. In these economies, any restraints on the supply of bank and other types of credit could have a more significant impact on activity as firms rely more heavily on external financing than in the United States. However, with better growth prospects, there is less risk of major negative feedback effects taking hold in the euro area. So far, credit to non-financial corporations has continued to grow at a high pace although credit to households, notably for house purchases, has decelerated. The United Kingdom, where the housing sector has started to adjust, may experience more pronounced effects. Japan’s banking sector and financial system has so far remained relatively unscathed by the turmoil. On the other hand, banks’ credit default spreads have increased dramatically in Iceland, where banks’ foreign branches have become so big in relation to the size of the economy (bank assets are nine times GDP) that serious doubts have emerged about the capacity of the Icelandic central bank to act as a lender of last resort to these banks. This has prompted the authorities to sharply increase their official foreign exchange reserves, including through currency-swap agreements with other Nordic central banks leading to some narrowing of credit default spreads.

Emerging markets are also affected

Financial markets in emerging economies have so far not been overly affected by the turmoil compared with past financial crises. Several of these countries have solid current account positions (with a number benefitting from high and rising commodity prices) while banks are to a large extent well capitalised and funded by domestic deposits. Signs of strains have, however, emerged in a few countries where private foreign currency denominated and/or public debt is high, the banking sectors are either not well capitalised or tend to be more dependent on wholesale funding in capital markets, and current account deficits are high. There is still a risk that a major financial crisis affecting one country would lead to a more generalised reassessment of emerging market risk.

Financial authorities have acted on several fronts

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Box 1.1. Measures taken to improve the functioning of money markets

The stress in money markets reflects a combination of liquidity hoarding and heightened counterparty risks and its advent has tested the limits and adequacy of the traditional response tools of several central banks. In the event, normal operating procedures were modified and new facilities introduced. While several of the most important changes in operations were made by the Fed, which faced both greater money market tensions and had at the outset a more limited set of tools at its disposal,1 a number of other central banks also changed methods and procedures. The figure below plots a measure of market stress from prior to the start of the turmoil to the present; the dates when some of the more important initiatives were introduced are noted with bracketed numbers that are referenced in the text.

● At the outset, financial institutions struggled to obtain credit at normal maturities. In the case of the euro area, the European Central Bank (ECB) introduced in mid-August of last year the three month supplementary longer-term refinancing operations (LTROs) (1). These facilities were renewed as tensions persisted and their maturity was lengthened to six months in mid-March.

● At about the same time, the Fed increased the maturity of loans offered to banks at the discount window, while cutting the discount rate, which in effect narrowed the premium (or penalty) for such financing, from 100 basis points to 50 and finally to 25 (2). In March of this year, the maturity of repurchase agreements offered to primary dealers was also increased with the creation of a new repo facility with a 28-day maturity, the single-tranche Open Market Operation Program (OMOP) (3).

● With US banks remaining reluctant to use the discount window, the Fed created the Term Auction Facility (TAF) (4) in which the same wide range of collateral as at the discount window is accepted but banks are able to bid anonymously.

● In order to ease strains on mortgage-backed securities (MBS) markets, the Fed also created (11 March) the Term Securities Lending Facility (TSLF) (5) for primary dealers where a wide range of MBS type collateral is accepted. The list of eligible collateral was extended in May to high grade asset-backed securities. On 21 April, the Bank of England also launched a scheme to allow banks to swap temporarily their higher quality mortgage-backed and other securities for UK Treasury Bills.

● Following the Bear Stearns crisis, on 14 March the Fed also announced the creation of the Primary Dealer Credit Facility (PDCF) which allows it to lend directly to primary dealers against a broad range of collateral (6).

● Two coordinated actions (12 December 2007 and 11 March 2008 (7)) were conducted involving the Fed, the ECB, the Bank of England, the Bank of Canada and the Swiss National Bank aimed at easing strains in the interbank markets.

The purpose of these actions was to try to improve the functioning of these critical markets. In point of fact, these actions did not result in more liquidity being injected into the financial system. The total volume of refinancing operations has remained stable, with longer-term refinancing operations now accounting for about two thirds of the ECB’s operations against less than a third before the turmoil. In the same way, the Fed’s balance sheet has not expanded, rather the amount of securities held outright has been reduced by 30% as both repos and loans to both commercial banks (via the TAF) and primary dealers (via the PDCF) rose. While the implementation of exceptional and new procedures undoubtedly helped, money markets still remain under considerable stress. Central bank operations can do little to reduce counterparty risks that have arisen because of a lack of transparency and a need to recapitalise weak institutions; rather the purpose of these operations was to buy time while the price discovery process progresses and institutions strengthen their balance sheets. The temporary storage of unwanted MBS may also limit destructive price adjustments and help to initiate a slow revival of these markets. However, such moves by central banks have raised concerns about the amount of risk they are carrying on their balance sheets (Reinhart, 2008).

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lowering the cost of resets for subprime loans, mitigating the impact of rising spreads on risky short term bonds, and by supporting banks’ lending margins.

There are signs that the situation is stabilising

Likely reflecting some of these measures, signs have emerged that the situation for banks has improved. Apart from being able to sell off part of their loan portfolios, financial institutions have seen equity prices at least stabilising while the prices of credit default swaps have declined, pointing to some improvement in counterparty risks.

Further financial risks remain

Despite these encouraging signs financial headwinds are still likely to persist and in the projections shown here they are assumed to abate only during the first half of 2009. Over this period, further strains could arise from a number of sources, including: a more pronounced adjustment of housing prices and further mortgage-related losses; a severe adjustment in the US commercial real-estate market; or a longer than expected US

Box 1.1. Measures taken to improve the functioning of money markets (cont.)

Money markets are still under stress

Note:Spread between three-month EURIBOR and EONIA three-month swap index for euro area; spread between three-month LIBOR and three-month overnight index swap for the United States. Numbers between brackets refer to the text.

Source: Datastream; and Bloomberg.

1 2 http://dx.doi.org/10.1787/364227813140

Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May

2007 2008

0.0 0.2 0.4 0.6 0.8 1.0 1.2

Percentage points

0.0 0.2 0.4 0.6 0.8 1.0 1.2 Percentage points

(1)

(2) (2)(7)(4) (3)(5)(7)(6)

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recession that would in turn deepen financial market losses. The situation in vulnerable emerging markets could deteriorate if, for example, the foreign banks that have been important sources of credit in Eastern Europe curtailed financing.

Once financial turmoil abates the recovery may be rapid

There are also upside risks. The vicious circle of fire sales, falling asset prices, and the liquidity squeeze may come to an end earlier than expected. If so, financial conditions could rebound quickly and in a reversal of the previous situation, a positive feed-back loop between financial and real recoveries could start. In this event, where monetary policy has been eased sharply, it should be re-normalised quickly.

The downturn in the global housing cycle is gathering pace

Housing investment is contracting

During the upswing, the credit cycle and the housing cycle were related and so it is in the downswing. In 2006-07, two-thirds of OECD countries experienced a peak in housing investment as a share of GDP, relative to the previous ten years. Past episodes suggest that per capita housing investment typically falls by about 15% in the two years following a peak, although there is a wide range of different experiences and many of the most extreme downturns occurred after sharp increases in interest rates (Figure 1.6). The United States is clearly well underway in this adjustment process. In the euro area, housing investment, both as a share of GDP or in relation to population, peaked in the first half of 2007. Over the past year, housing investment has decelerated in the overwhelming majority of OECD countries and has fallen in at least one-third, although substantially only in the United States and Ireland (Figure 1.7).

Figure 1.6. Previous housing investment cycles in OECD countries

Residential investment per capita, index peak = 100

Note:Dotted lines show inter-quartile range (half of countries lie in this range). Source:OECD Economic Outlook 83 database; and OECD calculations.

1 2 http://dx.doi.org/10.1787/363608420336

-5 -4 -3 -2 -1 0 1 2 3 4 5

60 70 80 90 100

Median

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Housing permits also indicate weak investment

Substantial drops in housing permits suggest that housing investment is likely to fall in many countries over the near term (Figure 1.8), although this indicator needs to be interpreted with care (Box 1.2). For the United States the continued decline in housing permits, as well as other advance indicators such as housing starts, is consistent with real housing investment continuing to fall substantially over coming quarters, and hence remain a major subtraction from GDP growth.

Figure 1.7. Real housing investment is decelerating in most countries

Year-on-year growth rate

1. Change in second quarter in 2008 is projected. Source:OECD Economic Outlook 83 database.

1 2 http://dx.doi.org/10.1787/363682860868

NLD CAN BEL GRC TUR FIN SWE ITA ESP JPN USA AUS NOR ISL KOR FRA AUT DNK DEU GBR NZL IRL

-30 -20 -10 0 10 20 %

To 2007q2 To 2008q2¹

Figure 1.8. Residential permits are falling sharply

Latest data, year-on-year growth rate1

1. Monthly data mostly ending between December 2007 and March 2008; three-month average over the same three-month average in the previous year.

Source:Eurostat; and OECD, Main Economic Indicators database.

1 2 http://dx.doi.org/10.1787/363723843411

IRL CAN BEL TUR GRC FRA DNK JPN ESP

NLD DEU GBR EURO NZL FIN NOR USA

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There are exceptions to future weakness in housing investment

There are, however, some important exceptions to the general tendency for housing investment to act as a drag on future growth. Japan experienced a sharp fall in housing investment, down 27% in the second half of 2007, due to the poorly-prepared introduction of more stringent building regulations. However, following corrections of procedures and regulations, housing investment is recovering strongly, boosting growth in the near term. Germany never took part in the housing cycle and housing investment is historically low in relation to GDP and is unlikely to fall significantly in the near future.

Real house prices are falling in many countries

For all but a few of the OECD countries for which data is readily available, real house prices (deflated by the consumer price index) are clearly decelerating, and year-on-year real house prices are falling in about half of them (Table 1.4). In Germany and Japan real house prices have been falling modestly for a number of years (with no obvious tendency for this to become more pronounced), but in other countries real house prices have only begun falling within this past year and mostly within recent quarters.

Box 1.2. Housing permits as an advance indicator of housing investment

Housing permits can be a useful leading indicator for housing investment, although the relationship is not such that a percentage change in permits translates into an equivalent percentage change in housing investment. This box reports empirical work to quantify the relationship between the two and uses recent permits data to examine which countries might experience a sharp fall in housing investment.

For each OECD country for which quarterly data is readily available, the change in (logged) residential investment was regressed on an intercept and up to four lags of the change in (logged) residential permits and up to four lagged dependent variables. Dummy variables were added for outliers. Where estimation over the full sample of available data led to failure of diagnostic tests, the sample estimation period was shortened. For a few countries (United Kingdom, Ireland, Korea and Netherlands) it is difficult to discern any simple stable historical relationship between residential investment and permits. For the 15 OECD countries for which data are readily available and it is possible to estimate a reasonable equation, the estimated long-run elasticity between building permits and residential investment is always well below unity; for some countries (United States, Canada, Belgium, New Zealand, Spain and Turkey) the elasticity is in the range 0.5–0.6, but for most other countries (Germany, Denmark, France, Greece, Japan, Norway and Sweden, as well as the euro area) the elasticity is in the range 0.15-0.3. Elasticities substantially less than unity can be explained by the fact that housing investment also covers expenditure on repairs, extensions which don’t require permits as well as multi-dwelling housing. Full details of the estimated equations can be downloaded from the OECD internet site at: www.oecd.org/eco/sources-and-methods.

An additional one or two month’s data on housing permits is typically available prior to the release of national accounts data on housing investment, although first releases of housing permit data may not always have full coverage which can bias the results in the direction of suggesting lower housing investment. The usefulness of permits as an advance indicator also depends on how far permits lead investment; for nearly all countries less than one-third of the long-run adjustment of investment to permits takes place in the same quarter.

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US house prices will continue to fall…

T h e ex t e n t o f t h e f u t u re f a l l i n U S h o u s e p r i c e s a n d i t s macroeconomic impact remains uncertain, particularly given that the rate of decline in house prices shows signs of accelerating.7 The immediate prospect is for a continuation of falling house prices, at least through 2008, given the backlog of unsold properties on the market; the number of months’ supply of existing single family homes at the current sales rate has risen from four to five months over the period 2000-06 to eleven months recently. The current projections incorporate a drop in

Table 1.4. Real house prices are slowing or falling

1 2 http://dx.doi.org/10.1787/363040337877 Per cent annual rate of change Level relative to

long-term average1

2000-2005 2006 2007

2 Latest

quarter 3

Price-to-rent ratio

Price-to-income ratio

Lastest available

quarter

United States 5.6 4.6 -0.1 -4.0 126 107 Q1 2008

Japan -4.6 -3.3 -0.8 -0.5 69 66 Q3 2007

Germany -3.1 -1.8 -2.2 -3.0 71 64 Q4 2007

France 9.4 10.0 4.9 3.1 162 141 Q4 2007

Italy 6.5 4.1 2.9 3.3 128 117 Q3 2007

United Kingdom 9.8 3.9 8.4 4.0 171 148 Q1 2008

Canada 6.2 9.1 8.7 9.8 194 137 Q4 2007

Australia 7.8 4.1 8.7 9.1 181 149 Q1 2008

Denmark 5.7 19.4 2.7 -1.9 165 151 Q4 2007

Finland 4.0 8.4 5.5 0.7 151 106 Q1 2008

Ireland 7.9 10.5 -1.8 -5.4 127 127 Q4 2007

Netherlands 2.9 2.9 2.6 2.2 157 158 Q1 2008

Norway 4.5 10.7 11.5 -0.6 166 133 Q1 2008

New Zealand 9.7 6.9 8.3 4.3 163 155 Q4 2007

Spain 12.2 6.3 2.6 -1.1 197 154 Q1 2008

Sweden 6.0 10.5 8.4 8.8 166 126 Q4 2007

Switzerland 1.7 1.4 1.3 -2.0 84 76 Q1 2008

Euro area4,5 4.6 4.0 1.6 0.4 129 113

Total of above countries5 4.2 3.6 1.6 -0.7 126 108

Note: House prices deflated by the Consumer Price Index. 1. Long-term average = 100, latest quarter available.

2. Average of available quarters where full year is not yet complete. 3. Increase over a year earlier to the latest available quarter.

4. Germany, France, Italy, Spain. Finland, Ireland and the Netherlands. 5. Using 2000 GDP weights.

Source: Girouard et al.(2006).

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nominal house prices (based on the OFHEO index) of 8% in the year to the end of 2008 and a further drop of 2% to the end of 2009.

… leading to higher foreclosures…

One reason for concern is that falling house prices are likely to boost delinquency and foreclosure rates (Figure 1.9) as the number of households with negative equity rises.8 Indeed, there is some evidence to suggest that people have become more willing to default on mortgages (rather than credit cards or other forms of debt) than in the past. Falling property prices have also led to a pick-up in delinquency rates in the commercial property sector. These developments imply further bank losses and so risk exacerbating the credit crunch.

... reducing consumption via wealth and collateral effects

Falling house prices will drag down consumers’ expenditure through a wealth effect. In relation to personal disposable income, housing wealth peaked at the end of 2006 while the estimated contribution it made to annualised growth in consumer’s expenditure has declined from about ½ per cent in 2006 to about zero in the first quarter of 2008.9 For every additional 10% fall in real estate wealth over the period to the end of 2009,

8. There may be a closer link between falling house prices and foreclosures in the United States than in the typical European country because of the “no recourse” nature of most mortgage loans. This means that, in the case of a default, if the value of the house is lower than the mortgage on it, the borrower is not liable for the difference. The borrower can walk away and send the keys to the bank (so called “jingle mail”). Even when the creditor may have recourse, the costs involved may sometimes be prohibitive.

Figure 1.9. Delinquency and foreclosure rates are rising in the United States

Share of loans

1. Delinquent loans are those past due 30 days or more. Source: Datastream.

1 2 http://dx.doi.org/10.1787/363742681824

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

0 2 4 6 8 10 12 %

Total Prime

Subprime

Delinquency rate¹

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 0.0

0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0

%

Total Prime

Subprime

Foreclosures started

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ECONOMIC

OUTLOOK

83

AND DEVELOPMENT

TABLE OF CONTENTS

TABLE OF CONTENTS

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Conventional signs

EDITORIAL

AFTER THE STORM?

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Chapter 1

GENERAL ASSESSMENT

Overview

Recent developments

Forces shaping the outlook and associated risks

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